The deferred target for fiscal consolidation

Prime Minister Shinzo Abe plans to divert part of the revenue from the next consumption tax hike to increase government spending on education, including free pre-school education for children, instead of being used to repay debt. Public investment in education is important for the nation’s future, particularly to ensure education opportunities for children from poor families in order to break the chain of poverty across generations. Abe says he dissolved the Lower House for a snap election this month to seek the judgment of voters on his proposal. It will be hard for many people to say no to the proposal, even if it entails delaying the government’s fiscal reconstruction target. However, the plan should be weighed against the consequences of putting fiscal rehabilitation on the back burner.

It’s not the first time Abe is seeking a voter mandate on a plan that few people would reject. The December 2014 snap election was held as the prime minister sought the electorate’s approval of his decision to delay the consumption tax hike to 10 percent, initially planned in October the following year, to April 2017. In June last year, he postponed the hike once again to October 2019 and asked for voters’ endorsement of the decision in the subsequent Upper House election. Each time the prime minister put priority on sustaining the economic growth under his watch. Both elections resulted in landslide wins for his Liberal Democratic Party-Komeito ruling coalition.

It’s estimated that the planned hike in the consumption tax from 8 percent to 10 percent two years from now will bring ¥5.8 trillion in additional revenue to state coffers annually. Under the current plan, ¥1.45 trillion of that amount will be spent on beefing up social security such as the pension program, medical services and child-rearing support, while ¥4 trillion will be used to repay debt incurred to cover the bulging social security expenses. Abe said he is changing the plan to divert ¥2 trillion out of the ¥4 trillion reserved for debt repayment to increase public spending on education. Greater government support for children’s education will reduce the burden of such expenses on households, possibly making room for more consumer spending — which plummeted after the last consumption tax hike in 2014.

The problem is that by using the tax revenue intended for debt repayment on policy measures, the plan now makes it certain that the government will miss its target of achieving a primary balance surplus — in which the state will be able to pay for policy-related expenses without incurring new debt — in 2020. It has already been deemed extremely difficult for the government to achieve the target. A Cabinet Office estimate in July showed that the state will have a ¥8.2 trillion primary balance deficit in fiscal 2020 — even assuming a level of robust economic growth that Japan hasn’t experienced since the 1990s — and that a surplus will only be attained in fiscal 2025. Under a lower growth scenario, the nation was still projected to be in primary balance deficit in 2025. Abe — who insisted that his administration will not abandon the 2020 surplus target even while he twice delayed the consumption tax hike — now admits that his plan makes achieving the target difficult.

The outstanding debts of the national and local governments combined have topped ¥1 quadrillion — the worst among the rich advanced economies. Japan has suffered a primary balance deficit since the 1990s, and the government’s target of a surplus by fiscal 2020 was a key landmark in its goal of fiscal reconstruction — and an international commitment designed to ease concerns about the nation’s fiscal health. Abe says his government will not shelve the agenda of fiscal rehabilitation. But it is questionable whether the boost in public investment on education — in itself an important policy — is an urgent step that must be taken by scrapping the road map for fiscal reconstruction.

The government’s social security expenses such as pension, medical and nursing care continue to mount as Japan’s population rapidly ages. Tax revenues alone cannot cover annual expenditures, and the government covers nearly 40 percent of the cost by issuing debt, which must be repaid in the future with interest. In short, the burden is being passed on to future generations.

The deferred burden will theoretically increase if the tax income reserved for debt repayment is used on education. If public spending on education has to be increased, the resources should be secured by reassessing priorities among existing programs, including a review of the welfare funds now heavily spent on the nation’s elderly population — for example by cutting benefits on the wealthy ranks of the elderly — to divert funding for the younger generations. It is over such social security reforms involving pain to certain parties that lawmakers will have to seek the endorsement of voters.